Analysis: Lessons From Midsize Companies

By Jeffrey Rothfeder |
Posted 11-01-2003

Analysis: Lessons From Midsize Companies

Even for a fast-on-the-trigger startup, it was a gutsy step. A year ago, before FRISA Wyman Gordon, based in Santa Catarina, outside Monterrey, Mexico, had opened for business, a team of internal software design specialists was putting the finishing touches on an enterprise resource planning system. Built entirely in-house and from scratch, the internal effort was something few companies of any size would dare tacklelet alone complete successfully. Yet FRISA's ERP system is now the calling card of its growth strategy.

"We're in an old, classic industry, not prone to IT innovation," says Hector Mario Cruz, head of IT at FRISA. "When you're a small player trying to make an impression in an industry, the first message that you want to send to customers is that [you] can provide the highest quality."

FRISA's immediate goals are not overly ambitiousto grab about 10 percent of the $600 million international market for forging turbine rings for aircraft engines in the next three years. But despite the modesty of FRISA's ambitions, the Mexican forge's ERP gamble illustrates something much larger: Small and midsize businesses, notorious for being at least a step or two behind technologically, are suddenly discovering that innovation paysor rather, they're making innovation pay. As the economic environment tightened over the past three years, many small and midsize companies, in a surprise departure from their behavior in other periods of slow growth, became more aggressive about creating strategic applications that link directly to the top and bottom lines. Instead of waiting out the downturn by ceding technology to their larger competitors, they've decided to go head-to-head this time.

"The mid-market is doing pioneer work in implementing technologies," says Jeffrey Read, PeopleSoft Inc. vice president and general manager for the mid-market. "These companies have the same business challenges as large companies, but they have smaller IT departments and smaller budgets, so they have to look for certainty of value. And they've learned that technology is not just a utility or a luxury; it's a differentiator and a necessity."

In FRISA's case, the decision to build the ERP system was an obvious one. The company, a spin-off of the large Mexican steel foundry FRISA Industrias, serves blue-chip customers, primarily General Electric Co., Rolls-Royce Corp. and Pratt & Whitney, all makers of aerospace engines, who expect extremely high-quality service. Parts must be manufactured to high tolerances, and response times for everything from shipments to tracing old orders must be

prompt and accurately gauged. All of FRISA's rivals are still using paper-based systems to drive these highly complex operations. But FRISA's management guessed that by becoming the first in its industry to automate and meet customer requirements better with an ERP system, it would get noticed among the 15 or so plants that forge turbine rings worldwide.

But there was a significant obstacle: FRISA ruled out purchasing a system from a software integrator, having determined it would be both too expensive and too risky given the many reports of dissatisfied ERP owners. If the system didn't work out as planned, FRISA would have run through a great deal of its capitalization with nothing to show for it. So Cruz's staff convinced the parent company to lend the startup some of its most experienced software developers to design and implement an ERP system that specifically met the needs of a steel business.

The ERP's data management component shows how closely the technology was tied to essential operationsand how it was geared to catch the eyes of potential customers. So-called traceability records that recount in detail every manufacturing activityamong other things, when and where the product was placed in a furnace, how it was forged and treated, and the date it was shipped outmust be kept for each turbine ring. If an airplane malfunctions, even years later, the engine manufacturer will have to produce a traceability record for each part quickly, so the cause of the mishap can be determined. At most forges, where paper files are the norm, it can take weeks to provide background material about a part. With the ERP system, FRISA can guarantee instant traceability. And, Cruz says, FRISA's decision to use in-house developers shaved as much as 50 percent off what it would have cost had he hired an outside software developer: "We had a solid team that knew the iron industry and understood what we needed. So we were satisfied with what we got."

Recent studies bear out the increase in technology activity among smaller companies. According to a survey conducted last summer of 300 executives at companies with annual revenues between $50 million and $2 billion by market researcher Grant Thornton International, 84 percent have invested in new technologiesor at least plan toto be ready for improved business conditions. Backing this up is a report by Access Markets International-Partners Inc., which concludes that worldwide IT and telephony spending in the group grew upwards of 7 percent in 2003, compared with 0 to 4 percent for larger corporations. According to AMI, larger companies are hesitant to boost spending when earnings and stock prices are under pressure, and there's "a general sense in boardrooms these days that recent IT investments in areas such as ERP or storage networks have yet to impact the bottom line."

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for a comparison of small and medium business compared to large companies.

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Some smaller to midsize companies have been motivated by the need to modernize old systems during slow periods and to be ready to take advantage of an anticipated burst of growth. Consider the Weitz Co., a Des Moines, Iowa-based general contractor for large office, institutional and industrial projects. In 2002, a soft commercial construction marketan aftershock of the Sept. 11 attacks, corporate accounting scandals and declining tax proceeds that have forced states to forego capital constructionsent Weitz's revenues tumbling to $745 million from $818 million the year before. Anticipating the downturn, Weitz's CIO, Mark Federle, suggested that the builder finally get rid of its old VAX-based network and replace it with an ERP system that would be managed by WTS Inc., an applications service provider for PeopleSoft.

The implementation began in November 2001 and the ERP system went live a year laterin time, says Federle, to take advantage of what Weitz executives believe will be accelerated construction activity in the company's new areas of focus: retirement communities, schools and healthcare institutions. Currently, the ERP system is mainly used for cost management, particularly to track real-time data about subcontractor billings and project expenses, and, in the process, limit endemic overruns. In the near future, Federle plans to add a CRM component and an estimating tool that will calculate up-to-the-minute costs of inventory, raw materials and labor to generate better construction bids. All of this is done with an eye toward squeezing out the most profit as Weitz pursues its ambitious goal of $1.6 billion in annual revenue by 2007.

"Technology was directly identified as a requirement for achieving the numbers in our strategic plan, during which we hope to triple in size between 1999 and 2007," says Federle. "We expect technology to drive efficiency and performanceand ultimately profits from the increased revenue. Without it, there's no way we could expect such outsized improvement."

But many small and midsize businesses don't have the luxury of planning for a four-year growth spurt. In most instances, they need results now, in the form of new sales and new customers. During the expansion of the 1990s, the economic pie was growing so quickly that even in markets with larger competitors, small and midsize companies were able to grab a slice of the customer base. But with the economy stutter-stepping, smaller players are not only finding themselves going head-to-head with each other; they're also facing rivals many times their size in the struggle to attract cautious consumers or, if they're a supplier, penurious companies. It's no surprise that 53 percent of respondents to the Grant Thornton survey said that the competitive environment in their industry was more intense than 12 months before. Smaller companies are obviously at a disadvantage against larger, well-heeled rivals, so they have to distinguish themselves from each other. That's where technology comes in: Rather than turning away from it for fear that wasteful spending will hurt the bottom line, many smaller competitors are adopting it as a necessary quick fix to seize increasingly elusive market share and new revenue.

Small and midsize businesses "must have immediate results with a short payback period," says Mark Oster, a partner in Grant Thornton's technology industry practice. "For that reason, in many cases, the systems they install are designed specifically to instantly extend the company's touch by bringing them closer to their customers. They're engineered to create a quick competitive distinctionways to stand out of the crowdas opposed to a competitive advantage."

An example is the system at Sonance, a high-end audio speaker manufacturer based in San Clemente, Calif. The company, which registers about $50 million in annual sales, relies on a network of dozens of independent dealers and retailers like Best Buy Co. Inc. to sell and install its products. Convincing these small and large consumer electronics shops to carry and promote the Sonance line over brands from bigger companies such as JVC and Infinity, not to mention as many as 100 niche players, is Sonance's primary challenge. Without an attentive distribution network the company can't survive. That's why Chip Brown, who became CEO four years ago after stints as a consultant for a venture capital firm and a product manager at PepsiCo, is determined to improve Sonance's somewhat tattered relationships with its retail network.

"When I arrived, we had an old, frustrating, non-computerized system for communicating with dealersa perfect way to alienate the people we depend upon," says Brown. "A dealer might call in an order on a Saturday night and not find out until Monday morning at the soonest, when someone called him back, that the speakers he wants aren't in stock. That hurt the dealer's business. It made it difficult for them to schedule installations and close sales. I was determined to build an infrastructure to get data to them in real time."

Brown says Sonance's success in the early 1990s is to blame for the threadbare technology: The company grew so quickly that it eventually outpaced the ability of its manual systems to serve customers efficiently. "Many companies don't realize that they're falling further and further behind on the technology capabilities that they need to sustain growth, and by the time they figure this out, it's two or three years later, when their growth has already been halted," notes Brown. "I was determined to implement a customer management system ahead of time, before we started to grow again, and before we missed another opportunity."

Brown and a team of Sonance employees, chosen to help select the technology they and their customers would be using, reviewed nearly 70 vendor bids for this system. In early 2003 they settled on a PeopleSoft ERP, which would let dealers place orders, retrieve account data, obtain product information and pay bills through an extranet known as SonaLinQ. It was an expensive undertaking for Sonance$2.7 million, or 5 percent of a single year's revenue, over five years. The only way Brown could justify such a high-priced effort was to identify a specific set of short-term and long-term benchmarks for the project, including quantified revenue and cost savings as well as specific improvements in customer relations.

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The charts are available in Adobe Acrobat PDF format. To download the free Adobe Acrobat Reader plug-in, click here.
Click here
for statistics on small and medium size businesses.

So far, the project has met the benchmarks. It was completed in six months, as scheduled, and 50 percent of dealer orders were placed through SonaLinQ in its first week of operation. Collection of accounts receivable has sped up and many distributors are downloading marketing materials from the extranet, cutting in half the number of calls Sonance customer service reps must handle. As a result, Brown has canceled plans to hire more people, a significant cost savings. And the system lets Sonance keep track of dealer-ordering patterns more precisely and, thus, better anticipate purchases and ship most products within 24 hours. All told, Sonance expects $9.4 million in increased sales and cost savings over five years from SonaLinQ, including about $6 million in revenue from new dealers and distribution channelsmuch of it business its rivals could have won. Most important, says Brown, SonaLinQ goes well beyond what its closest competitors have to offer.

"When you're a small or midsize company, your first line of defense is your only line of defense," says Brown. "That's what SonaLinQ represents. Customers remember when they can't reach a company for two or three hours, and that bad taste never goes away. Customers may not always outwardly express appreciation for great service, but they're turned off by bad service. Hopefully, that's in our past."

Perhaps the most impressive part about many of the newer implementations at smaller companies is how few of them end up over budget and behind schedule. Small and midsize businesses have little margin for error and tend to be extremely demanding about keeping projects on course. For one thing, they usually phase in technology one small step at a time, measuring it at predetermined intervals to see whether it meets certain organizational integration or financial performance requirements. To match this painstaking approach, many hardware and software providers targeting small and midsize businesses are offering accommodations that vendors have been hesitant to suggest in the pastincluding fixed-price bids, implementation guarantees as short as 90 days, and assurances of return on investment.

Smaller businesses "can't afford to do a Big Bang project because of the risk associated with it," says Jim Upton, senior manager at J.D. Edwards' Enterprise Asset Management group, now part of PeopleSoft. "So we have to do everything we can to give them a comfort level that the project won't get out of control."

Some of the more unique guarantees are coming from outsourcersan option that is slowly attracting small and midsize companies, which have very limited IT staffs and difficulty supporting in-house technology. For a long time, small and midsize businesses viewed outsourcing as too grandiose an idea for their minimal use of computers, perhaps 60 to a couple hundred desktops. But with technology playing an increasingly important role in determining their future, top management has begun to reconsider outsourcing as a way to maintain both the basics of in-house computing, such as e-mail, security and simple programs such as office suites and presentation software, and new, necessary corporate strategic applications.

Outsourcers have responded to this shifting landscape by offering no-lose deals that many small and midsize companies can't refuse. Customers of LuxScientiae Inc., a Boston-based e-mail and network server outsourcing company, are promised a refund of 5 percent of the monthly fee if its network's downtime exceeds 24 seconds per month. RightNow Technologies Inc., a Bozeman, Mont., builder and host of CRM applications for small and midsize businesses, lets potential customers try out live before signing an outsourcing contract. Perhaps the most radical deal is offered by CenterBeam Inc., a San Jose, Calif.-based outsourcer that targets companies with up to 2,500 employees. Instead of long-term contracts for managing a client's technology infrastructure, CenterBeam offers month-to-month service agreementsin the simplest cases, costing about $50 per month for each desktopthat can be canceled with 30 days' notice.

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That promise hooked John Musil, the CEO of Apothecary Shops of Arizona, a ten-store pharmacy chain headquartered in Scottsdale that focuses on providing drugs and medical equipment for diseases affecting women and children. Until recently, each Apothecary branch operated as a standalone store. This put the company at a distinct disadvantage compared to large national drug retailers, which have centralized record systems that allow customers to fill prescriptions at any outlet. It also made it difficult for Apothecary to cut sweetheart deals with manufacturers, because no pharmacist could easily produce a chainwide accounting of individual items sold, a tally that medical equipment makers use to determine which retailers deserve special discounts. Since Apothecary promises customized treatment for unique medical conditionsincluding the skills and inventory to make complex compound drugs and keeping a large number of medical devices on handthe lack of an integrated computer network meant that the company was operating by the seat of its pants and mostly in the dark.

"We're a great pharmacy organization, not an IT organization," says Musil. "My corporate communications director was de facto head of IT, but when IT suddenly represented more than keeping a desktop computer operatingwhen it represented whether we could continue to compete in our own businessI knew we had to look outside."

CenterBeam's month-to-month deal made Musil's decision easy. If his plan for an outsourced storewide system didn't work, he could get out of the relationship with very little money and time invested. A network linking up all the Apothecary stores debuted in late 2002. Now, each store could view the customer and inventory databases, and management could obtain a complete picture of company activities. Musil says it has greatly improved the operating margins at his $50 million company (by contrast, Walgreen Co., which also does business in Arizona, has nearly $29 billion in annual sales). Sharing patient records among branches and keeping track of sales by store, or even by the healthcare provider who prescribed a drug or a device, are important benefits, as are two unexpected ones: Pharmacists from different branches are swapping war stories over the network, sharing their experiences about making drugs for more complex conditions, so they don't have to spend hours solving problems on their own. Meanwhile, company-wide inventory has been consolidated.

"It gives Apothecary the advantages of a larger chain without losing our distinct identity as a clinically based pharmacy," says Musil. Next step for the network is e-prescribing: Physicians will be able to send in prescriptions via PDA, an application that's 90 percent finished and that no pharmacy in Arizona, large or small, offers.

The renaissance in technology activity at small and midsize businesses is borne out of desperation, which even more than necessity is often the mother of invention. All of the small and midsize businesses interviewed for this article said that they would have found it difficult to thrive or even survive had they decided to save the money and avoid the risks of a new system, either internal or outsourced.

"The market's upside down," says CenterBeam CEO and president Kevin Francis. "A few years ago, no one would have expected small and midsize businesses to lead a new round of technology spending. But that's the sweet spot now."